It's very simple. Without inflation, governments will hit the brick wall of inability to service, and thus refinance, their debt sooner than later. And this will lead to massive social unrest. The Economist, and central banks, know this very well. It is why inflation, by any means, is inevitable. It is seen as the lesser of two evils, and a stealth transfer of wealth.

We shouldn't fear deflation. Deflation might just be exactly what we need now. Since the depression in the 1930s we have feared deflation and done everything we can do have constant inflation.

This has now lead us down the wrong path, where we ask an already overpopulated planet to have more kids to sustain growth. We cheer hyperinflation in property and any growth, weather detrimental or good is cheered like something we want. We print money, we borrow ourselves into pits, we lower interest rates at all time lows etc etc.

But does deflation not have to come regardless? Bubbles are building all the time, record bubbles, record debt, record everything, mostly nowadays bad things. We had a global financial crisis since 2007 and it is still ongoing, new chapters are being written all the time, what is the next one?

Deflation seems to be a matter of how bad it will be. The way we are building it up, it will become devestating, since all the bubbles will burst at once. And now we feed the bubbles.

Deflation and inflation are two things of the same parallell, and they both need to occur in controlled forms. Not just inflation.

Bubble inflation refers to very specific asset classes, not the economy as a whole. While it is probable that stocks and a few other assets are in bubble territory right now, it is nowhere near the scale we saw in 2008, or in the tech boom of 2000.

To say that we need some kind of crash to blow things up, bring our economy to a halt and throws millions more out of work for the sake of somehow bringing about prosperity is completely insane.

What we have right now is an economy operating way below potential - tens of millions out of work, crumbling infrastructure, large output gap, etc. In order to return us to growth, and this really isn't all that complicated, the people of this nation need the MONEY to purchase the goods that they can and want to consume; to have people idly sitting around with no job because we are collectively too ignorant to pull our heads out of our asses is borderline criminal behavior.

Jobs programs, tax cuts, or some combination of both. Central banks have nothing to do with this picture.

Capitalism is the problem. It is built on the premise of ever increasing demand for goods and services and ever rising prices and profits. It is destroying the planet, depleting natural resources, polluting our air and water, producing products of questionable value, and causing catastrophic climate change. If you stop fueling the growth, the beast will starve. Maybe it deserves to starve.

You know what else is profitable? Cutting down all the planets trees and burning these. But the end game would not be nice. But we are getting there, slowly.

Capitalism never considers consequences. And for what? So that a few people can steal as much of the value of the labour of the rest as they possibly can? And when they cannot steal more, they want the production to increase?

Where is the shuttle to another inhabitable planet I ask? This place is too full of fools.

You know what else is profitable? Cutting down all the planets trees and burning these. But the end game would not be nice. But we are getting there, slowly.

Capitalism never considers consequences. And for what? So that a few people can steal as much of the value of the labour of the rest as they possibly can? And when they cannot steal more, they want the production to increase?

Where is the shuttle to another inhabitable planet I ask? This place is too full of fools.

Capitalism is only one word to describe volumes worth of systems, behaviors, and outcomes. Saying it is the problem serves nobody. One could also say that capitalism is the reason why 1 billion people live more luxuriously today than the kings of 300 years ago. Although I do agree exponential growth is an outdated model and those who want to choose a different model might consider the sustainability & prosperity model (trademark).

US GDP per capita grew 1.4 pct 1800-1900 with deflation in peace time and inflation during war time. Overall prices rose zero pct over 100 years.

Economists in the mid 20th century, not understanding that deflation under sound money regimes spring from productivity increases, figured the US must have been in long depressions between 1800 and 1900. But it was the times of peace and progress of living standards that brought about deflation. Things became cheaper, just like PCs and clothing have become cheaper for us in the 1970s-2000s. Are we worse off due to these cheaper items? Progress or regress?

Inflation is a sign of scarcity, productivity regress and war-production or other non-civilian allocations. Deflation is a sign of abundance, peace and productivity progress.

If someone prints money for himself and tells you it's for your good too, you dont trust him. Unless he takes on a government title and brain washes you first to think its good, that you are cheated.

This is a very good post and it springs something to mind which I am very stubborn on.

There are two types of growth. Quantitive growth and quality growth. Right now my feeling is that we ONLY focus on quantity, and that the economic model is only taking that into account. Capitalism as it is now is problematic in this way.

There is no point in measuring GDP per capital if this GDP per capital is poor GDP per capital. Far more important in my mind is, what kind of quality can we get out of that GDP per capital?

You make some good points and I was thinking along the same lines. Isn't deflation the whole point of productive economic activity? The whole point of being productive is to provide more and better goods and services. If we make more goods and services they become less scarce and their price should decline. Why do we fight this? Japan is always held up as the poster child for how bad deflation is because of their slow growth. But Japan has enjoyed significantly lower unemployment than either Europe or North America. And the Japanese people enjoy a very high standard of living. One reason why their standard of living is high is that they can afford to buy things because inflation hasn't evaporated their savings and/or income.

We (you, I and other civilians) don't fight deflation. It's just that a few people are being allowed to create new money, ie new generic rationing cards. And so, as the formula MV=PQ indicates, prices go up for the rest of us. We do not get that money until it's worth a lot less and we have to work to earn it.

What history before 1914 indicates, is that living standards will grow steadily under normal innovation without someone being allowed to constantly print money for themselves. It is stealing really. We need a generic rationing card, we can trust to ration goods and services. After all, you and I would go to prison if we created new rationing cards. And who would voluntarily accept a money type that can be created out of thin air. It's fiat money.

If you want to think more about what money is, I recommend looking up the history of money and the concepts of legal tender, fiat money and fractional reserve banking. Kings used to clip coins, but digital/ pure accounting legal tender money is a modern concept. It's quite shocking that we are still not out of the monetary regime caused by world war one, 100 years ago.

Japan has the same fiat monetary regime and it likely co-caused the 1990 stock bubble and the following ongoing government bond bubble there that has been supported through ZIRP. The Japanese have lost a lot of their saving twice the past 30 years. Once in each bubble. Their government is broke. That's why they are printing (so-called Abe-nomics).

Why don’t you consider the interests of creditors? Moreover, in long run, there is no obvious substitutes relationship between unemployment rate and inflation rate . Moderate deflation caused by prices falling could improve the competitiveness of enterprises. The cost and price advantage of company is very important, especially, under the situation lacking of innovation now. If enterprises have investment desire, the unemployment rate would fall. Driving unemployment rate to fall by inflation would be a bad idea.

Inflation is an important form of taxation for the government. It has many desirable qualities: the amount of taxation can be adjusted quickly; it is difficult to avoid; most people are not even aware they are being taxed; it has low implementation costs; and has the additional advantage of reducing debts denominated in the local currency. Evidence of its widespread use is found in the way nearly all governments lie about the official rate of inflation, which they maintain is much lower than the truthful rate of inflation.

Try telling people in my country, India, that inflation is too low. Since last August there has been 245% rise in the wholesale price of onions. Onions are a staple here, and millions of poor people who spend the majority of their tiny income on food will be amazed by this article. TE may number the Rothschilds amongst it's shareholders but it should endeavor to stay in the real world.

Middle class and poor Americans are hurt by inflation too. The outrageous inflation in the cost of higher education and health care over the past couple of decades is a real burden for non-rich Americans.

Central banks, especially the Fed if they want the US dollar to maintain its reserve currency status, need to worry about how they'll soak up the liquidity they created when the economy picks up. Selling the bonds they purchased will do some of the trick but interest rates will be higher so the bonds will be worth less than they paid.

Bankers around the world are all bidding for more stimulus. This is a delusion. The root cause is globalization. Western civilization faces a long-term problem of cost structures that will not go away until there is prize equalization -- or war. The Fed can't beat this systemic dynamic and if this monetary craziness goes on much longer it will have a devastating effect.

"In Japan deflation did not set in until seven years after the asset bubble burst."

There are 2 kinds of deflation: 1. Decline in prices as a result of technology and improvement in productivity, 2. Decline in prices when a credit bubble meets its inevitable end.

Like Japan, the industrialized world is experiencing the latter after years of attempting to remedy the former. The first kind of deflation is benign and natural and should not be staunched lest we end up with the 2nd. In the wake of the 2nd we shouldn't try to reinflate the bubble. Why? Because it was a mistake to begin with, it doesn't work, and more perniciously, because the liquidity ends up in all the wrong hands: the rich, the wealthy, the bankers, the paper pushers, and into assets, which the rich own the most of. Little wonder that the rich have only gotten richer, and the middle class/poor have gotten poorer.

The Economist writes that "in popular perception, and in their own minds, central bankers are the technicians who squeezed high inflation out of the rich world’s economies in the 1980s." But these are lies bankers and economists tell. Inflation is created by central bankers and only when things get out of hand do bankers attempt to "squeeze out inflation". Their preferred method of looting society is slowly and inconspicously through low levels of inflation the damage which can only be recognized years later.

By now, we should be very tired of the orthodox ideology of "inflation" that benefit the rich, the well heeled, the financial industry, and politicians. The Economist says that "the biggest problem facing the rich world’s central banks today is that inflation is too low." Yes, perhaps this is so, in an ironic sort of way. Low inflation is a banker's problem. But it's not the people's problem. The people would do well without inflation and also with bankers who pretend to be do-gooders instead of the parasites that they are.

Aside from the two first paragraphs that are good, the rest is communism.

Please explain how "the rich" (what a nice, emotionally charged shortcut) benefit from inflation, which is in fact a method of taxation that targets the rich more than anybody else to benefit government finances and by extension, everybody BUT the rich.

Thank you, wall clinger. I quote your sense and all your words.
TE tries to convince us that deflation is the villain and that inflation will rescue us.
Every reaeder of TE (journalists will follow) knows perfectly well who real world villains are. You name it: greedy bankers, corrupt politicians, inept managers, polluting industries, drugs dealers, civil servants in charge of inefficient public services, tax dodgers, lazy renters, and so on.
I add printer friendly FED and Bank of England, big bubble shufflers on Big Bank and Big Corp Inc. payrolls.
Well, believe it or not, all those real villains together add a hefty cost to the production of goods and services (i.e. things that real people need).
Wipe the real villains out and, arguably, TE will see new “perils of falling inflation”.

"Please explain how "the rich" (what a nice, emotionally charged shortcut) benefit from inflation, which is in fact a method of taxation that targets the rich more than anybody else to benefit government finances and by extension, everybody BUT the rich."

Inflation targets the asset-less class, namely the middle to poor.

Flexible monetary policy was created to benefit the rich, ie, business and industry. How does a central bank pulling the levers benefit industry? Because when business needs credit and there is no credit to be had at the price they can afford, the kindly central banker pulls the levers to lower the cost of money, and voila, business can borrow from thin air, except it really isn't from thin air. The cost comes in the form of inflation to the middle class and poor. And indirectly, the funds were borrowed from the rest of us unbeknownst to us and without our permission, at below true market rates. The wealthy, who are always the most leveraged and borrowed, pickpocketed our collective pockets with the help of the accommodating central bank.

I believe both option 1 and 2 are in effect and that is the real problem. Looking at past engines of job growth and not taking into consideration that we have less jobs because we need less of peoples time is the real problem. Time is becoming less of a commodity others will pay for.

Automation has arrived without much notice. In the end you do not need a robot repairperson when the robot lasts longer or can do the job of twenty people for a 100th of the cost. Look around you and you see the white collar office is now gone and the entire eco system.
How many people now work from home and telecommute when needed. How many janitors are not longer cleaning those offices and how much empty commercial real estate do we have. The US added 32 million people to the population but only 2 million new jobs but GDP grew due to automation. That is the problem.

January 2000 had 128 million people with non-farm jobs
January 2013 had 130 million people with non-farm jobs

Year 2000 population was 281 million people
Year 2013 population was 313 million people

January 2000 was 64.6 percent of the population over 16 with a job
January 2013 was 58.6 percent of the population over 16 with a job

The Rich (side note--I like the rich if they are nice and earn their money by producing what people want and need) benefit from inflationary policies because of leverage...that is the short version.

Inflation--expansion of the money supply--its effects most felt when banks turn the base money into loans (fractional reserve banking). Since the rich have working capital they turn say $1,000,000 cash into $5,000,000 worth of investments assets that cash flow a return. After years of good ROI they payback the $1,000,000 with interest and get to keep everything else. Since they borrowed 5:1 and inflation was say 1.05:1, the gains outpace the loss of purchasing power from inflation. Make sense?

Perpetual inflation--for how long before system becomes unstable (positive feed back loops can't go on forever). If you want money to retain some value (a stable system) then you will have to figure out how to have both inflation and deflation. I guess people have stopped understanding the second law of thermodynamics and believe you can get something for nothing. Hello Dark Ages.

Deflation is a blessing for the ordinary person. It lets us buy more at the store with our paychecks and pensions. Deflation slowly improves the lot of the average person by making paychecks/pensions buy additional goods.

Inflation is primarily a bank bailout. Printers are only too happy to give workers and retirees a real pay trim to bail banks out of silly loans banks made. The sad part is that printing misallocates capital, thus requiring an even bigger bank bailout in a few years. When banks printed the housing bubble to bail banks out of Y2K, this just made banks demand a super bailout from the housing bubble.

You are assuming that prices will go down but wages will not, an almost non-existent phenomenon in history. If producers are suddenly confronted with lower profits due to lower prices, you can be damn sure they will pass that on to their workers.

You are missing the prime beneficiary: Goverments, the only way they can get away with unsurmantainable level of debt is trough the printing press thus gradually reducing the purchasing power of their's IOUs (Legally Looting Society).

Yes, but wages are "sticky" to the downside and there is never any "suddenly" in the eventual reduction. (Which also tends to be a reduction in the rate of increase rather than an absolute diminution.) So the 'ordinary person' will in fact benefit for a considerable period from a bout of deflation (or negative inflation).

When has that ever happened? It's much too simplistic of an analysis here to be of any use, we almost never in practice have a period where prices unilaterally decline. The last period of time where we had serious deflation was the great depression, and wages most certainly were not sticky at that time.

It is always a question of what in relation to what. For the past 30 years real wages in the US have slightly declined. Some prices (housing, education, healthcare) have gone up, some have gone down (electronics, etc.) The important point is that in relation to the overall increase in prices, wages have not kept pace.

I agree with your point about the last 'serious deflation' and we don't want another major depression like that. But surely your second point lends weight to my view: why have the 'real wages' declined? Isn't it precisely that nominal wage increases have been outdone by price increases (aka inflation)? Maybe a bit of general price deflation would assist to maintain/increase the purchasing power of the average wage earner. Thanks for you comments in any event.

"Isn't it precisely that nominal wage increases have been outdone by price increases (aka inflation)?"

Agreed.

"Maybe a bit of general price deflation would assist to maintain/increase the purchasing power of the average wage earner."

Right, but how does one engineer broad price deflation without bringing wages down with it? Or even in one industry for that matter.. I can think of many (politically impossible) ways to bring down healthcare costs, but it is definitely going to affect the way people are paid in that field, or if they even get paid at all.

I think we're both in general agreement; it seems that we should attempt to avoid either destructive inflation or destructive deflation, both monsters. But maybe a little deflation might not be so bad for the average guy (at least the ones who don't have large debts!).If you have broad price deflation, that will probably be accompanied by wages level movements to the downside, but at the same leisurely pace that inflation engenders upwards adjustments. The latter hurts people immediately while the former at least gives some (albeit) temporary respite. Don't forget that inflation benefits most those who are closest to the money spout, viz. bankers and 'Wall Streeters'. If deflation has the opposite effect wouldn't that be a nice change? As to your question, I don't have an answer; maybe you can't. Life is not always fair or equable.

You're making a disconnection that increasing efficiency and greater supply will actually decrease profits, this has not been the case throughout history, infact increasing supply throughout the industrial revolution (thus falling prices) and when the Asian economies developed caused huge increases in wages.

Ok, but no one is going to increase their supply if there isn't anyone to purchase the product. Demand comes first, not supply. Right now we have tens of millions out of work and a large output gap, and still we have positive inflation.

The measures of inflation themselves are highly debatable and we're always talking about X in relation to Y so I find inflation a very difficult topic to discuss.. but I don't see how a government can CREATE deflation unilaterally without bringing the economy down at the same time.

As far as the United States is concerned, the "headline" inflation rate of 1.2 percent last September, down from 2 percent in July, is far from being noticed by many people let alone given them cause for worry.

The U,S. economy obviously still needs some more pump-priming, which explains why the Feds continues to release the huge amount of $85 billion a month into the economy. The Feds rates has long been in the vicinity of ZERO, and chances are that it will stay at that level for longer, even under a new Feds chairman.

The American people still entertain horrible memories of the time when INFLATION pretty much went up to near-uncontrollable levels, and took a determined Paul Volcker to do the herculean and even draconian job of bringing it successfully under control.

Reading this article, and others like it in the popular press, make me feel as though I am down the Rabbit Hole with Alice in Wonderland. I somehow developed an understanding over the past few decades that the 2% number is an inflation cap, not a target, and that a neutral monetary policy is the only hope for allowing the price mechanism of a free marketplace to work its magic to most efficiently allocate resources. I hope that sometime during my remaining lifetime the manipulative monetary policy of central banks (aka governments) will be recognized for the political sham that it is.

Exactly! Rising prices increase the separation between the rich & the poor & the haves & the have nots.

Why, if prices were to deflate, the poor & middle classes might be able to afford houses again & the cost of renting apartments might not break their financial backs (the high cost of housing being one of the leading causes of poverty in America).

So, by all means the banks should get their inflation sticks out to beat back the poor & middle classes. Let government throw them a few subsistence crumbs, but lets get inflation back on course.

Inflation is not the cause of income or wealth inequality. In fact, it directly improves the situation by redistributing wealth from people with positive net worth to people with negative net worth (Because the rich lose a portion of their investment return over time to inflation, while the poor/indebted get to pay back loans with money that is cheaper than when they took out the loan, sometimes to the point that in real terms they "pay" negative interest). Now, if that is actually a good thing or not depends on your political beliefs, but that's the macroeconomics of it.

Just the opposite. Printing regressively confiscates purchasing power from the poor. Their meager paychecks buy less food at the store, which is why so many are on food stamps now. The poor depend primarily on paychecks, not bank loans. The third world poor are especially devastated by printing food inflation, as they don't have food stamps.

A generation ago, on median paycheck could support a family. Thanks to decades of wanton printing confiscating paychecks, now it takes 2 paychecks.

Everything else being equal, wages rise with inflation at the same rate as prices. Of course, everything else is not equal, as most recent income growth has concentrated at the top. This is not the fault of inflation... You can tell because the disparity in wage growth is very large, while inflation (in the US) is very very small.

Inflation is a tool of redistribution. Who is more hit by a 2% annual reduction in the value of his cash reserves, the rich (where 2% can be millions) or the poor, who typically have no cash reserves to begin with?

Inflation is a government tool of progressive taxation that in real terms transfers wealth to the poor. This is first semester textbook economics.

"Poor" and "the indebted" are are not interchangeable. Truly poor people can not get credit on terms that would allow for eventual negative interest rates. That is, they either can't get credit at all or they are charged a significant premium for whatever credit they can get. The middle class can borrow but it is certainly questionable whether significant indebtedness is in the long term interest of most middle class people. The only way the middle class benefits from inflation is by going deep into debt.

They may go up in price, but they don't go up in value: that's exactly how inflation does its damage, even if insidiously and generally unnoticed day to day. The indebted person on the other hand (and that may include both 'poor' and 'rich' people however you define those two labels) benefits at the expense of the creditor. That's why governments ( the biggest debtors these days) like inflation.

Almost, not quite. Inflation steals from the middle class to redistribute to the poor and the rich (the rich stay rich because they adapt to changing economic environments). The rich seek out the ventures (like government contracts, asset bubbles before they pop, etc) that arrise due to the inflationary policies. Not sure if this is true..ask 10 rich people...the details change, but the story stays the same. Still not sure...ask 10 middle class people (if you can find them anymore in the US ;)

What people opposing TE's argument tend to miss is that credit basically equals money. From 2008 credit has contracted much faster than QE has been able to replace it - that's why high inflation wouldn't be logical (and that's why it isn't happening).

Anybody with half an hour should watch "How the Economic Machine Works" from Ray Dalio, a macro investor who's been calling the economic cycles for decades. It's an eco 101 kind of thing, but more insightful than most eco books

"From 2008 credit has contracted much faster than QE has been able to replace it"

QE does not replace credit, that is why it doesn't create inflation. Credit is created when someone decides to borrow, not when the Fed swaps one asset for another of equal value (i.e. reserves for treasuries).

No, TE's ASSUMPTION is that any decline in prices is 'deflation' and deflation is always bad. That's not an argument; it's rote repetition of cant - like chanting in unison in North Korea from the thoughts Kim Il Sung. Unfortunately, it is what passes for reasoned analysis among the staff at TE.

Good article. This cannot be restated often enough, it seems. Too many nutters out there convinced that we're one funny look away from Wiemar Republic level hyperinflation. Or that we're already in hyperinflation and that there's some vast conspiracy to fake the CPI. The Fed has done a pretty great job over the last 20 years of keeping inflation low and stable, but since the recession they've been scraping dangerously close to deflation. I'm not sure there's much they can/should do about it... A large part of why we're not seeing more inflation from QE is that banks, companies, and rich people are sitting on their money instead of spending or investing it, and there's no responsible or desirable way I can think of to force them to increase the currency velocity. I cannot speak to the EU, but I think the Fed is doing everything it can reasonably do to avoid the deflation trap.

A predictable, unoriginal, almost worthless re-print of the same tired argument TE has been making for years now. It's not any more coherent now than it ever has been - 'prosperity through inflation' is a mantra nobody outside academia and bureaucracy is buying anymore - we know better, even if the TE-staff hive-mind doesn't. There is one useful nugget in the piece, though ...

UK inflation is a full 2.7%, yet their QE-rate is no greater than what the Fed has been doing. BOE's QE hasn't been confined to purchasing bad assets from The Street, as the Fed's has - and unlike the US where fully half those new funds make a round-trip and end up back on deposit at the CB - UK QE circulates, and inflates.

If the Fed actually wanted inflation it would force the reserves deposited with to be withdrawn and spent - then we would have inflation, and the Fed knows it. They don't actually want inflation, no matter what they say 'on the record'.

The Fed had to try to somehow plug the holes that were blasted into balance sheets with the housing collapse and the other asset wipe-outs. The only source of money big enough to cover that was from QE, but QE creates inflation IF the QE$ circulate.
.
The way they set it up put the cash onto the balance sheets of banks, covering their losses, but kept it at the Fed, not circulating and producing inflation. So banks have a ton of their money on deposit at the Fed; money they are not allowed to spend, lend or use because it would be inflationary to do so.
.
To answer your question, the Fed has what it wants - it's protected its (and everybody who matters') patrons on The Street with taxpayers QE-money. Nobody at the Fed or in DC actually cares about anything else. The only concern now is to try to keep the thing they've constructed from collapsing under its own weight - and the tremors caused by even talking about throttling back on QE shows just how gossamer the construct is. Everybody is scared and nobody actually has an real confidence about what to do now - but they know they can't do QE forever, but haven't the courage to stop.